744 F.

2d 255

Fed. Sec. L. Rep. P 91,564, 5 Employee Benefits Ca 2706

NORLIN CORPORATION, Plaintiff-Appellant,
v.
ROONEY, PACE INC., Patrick J. Rooney, Piezo Electric
Products, Inc. and John Does 2-10, Defendants-Appellees,
PIEZO ELECTRIC PRODUCTS, INC., Defendant and
Counterclaimant-Appellee,
v.
NORLIN CORPORATION, Counterclaim DefendantAppellant,
and
Andean Enterprises, Inc., Norlin Industries, Inc., Norton
Stevens, Gilbert A. Simpkins, Zachary Marantis, James
McGuiness, Harold Krensky, Katharine T. O'Neil, Edward R.
McPherson, Jr. and James K. Baker, Additional Counterclaim
Defendants-Appellants.
No. 1427, Docket 84-7360.

United States Court of Appeals,

Second Circuit.
Argued June 1, 1984.
Decided June 27, 1984.

John Logan O'Donnell, Olwine, Connelly, Chase, O'Donnell & Weyher,

New York City, for counterclaim defendants-appellants Norlin Corp.,
Andean Enterprises, Inc., and Norlin Industries, Inc.
Gregory P. Joseph, Fried, Frank, Harris, Shriver & Jacobson, William G.
McGunness (on the brief), New York City, for counterclaim defendantsappellants Norton Stevens, Gilbert A. Simpkins, Zachary Marantis, James
McGuiness, Harold Krensky, Katharine T. O'Neil, Edward R. McPherson,
Jr., and James K. Baker.
Jonathan J. Lerner, Skadden, Arps, Slate, Meagher & Flom, New York

City, for counterclaimant-appellee Piezo Elec. Products, Inc.

Before FEINBERG, Chief Judge, KAUFMAN and PIERCE, Circuit
Judges.
IRVING R. KAUFMAN, Circuit Judge.

Contests for corporate control have become ever more frequent phenomena on
the American business scene. Waged with the intensity of military campaigns
and the weaponry of seemingly bottomless bankrolls, these battles determine
the destinies of large and small corporations alike. Elaborate strategies and
ingenious tactics have been developed both to facilitate takeover attempts and
to defend against them. Skirmishes are fought in company boardrooms, in
shareholders' meetings, and, with increasing regularity, in the courts.

The efforts of targeted management to resist acquisitive moves, and the means
they employ, have been alternatively praised and damned. Proponents of
corporate "free trade" argue that defensive techniques permit managers to
entrench themselves and thus avoid accountability for their performance, at the
expense of shareholders who are denied the opportunity to maximize their
investment in sought-after corporations.1 Opponents contend that takeover
struggles squander enormous capital resources which could better be spent to
improve industrial productivity and to develop and commercialize new
technologies.2

When these battles for corporate dominance spawn legal controversies, the
judicial role is neither to displace the judgment of the participants nor to
predetermine the outcome. Rather, the responsibility of the court is to insure
that rules designed to safeguard the fairness of the takeover process be
enforced. Our most important duty is to protect the fundamental structure of
corporate governance. While the day-to-day affairs of a company are to be
managed by its officers under the supervision of directors, decisions affecting a
corporation's ultimate destiny are for the shareholders to make in accordance
with democratic procedures.

The instant case involves defensive action taken by a company that feared it
might soon be the target of a takeover attempt. The first salvo in this battle was
fired by appellee Piezo Electric Products, Inc., which in conjunction with
Rooney, Pace Inc., began buying up large blocks of stock of appellant Norlin
Corporation. In response, the board of directors of Norlin issued new common
and voting preferred stock to a wholly-owned subsidiary and a newly-created

employee stock option plan. Since Norlin would control the voting of the
newly-issued stock, the effect of the transactions was to concentrate greater
voting control in the hands of its board of directors, and thus to ward off any
acquisitive moves that might be made against the company. Piezo sought and
the district court granted a preliminary injunction barring the board from voting
the stock in question. The judge found that any vote resulting from these
transfers would likely be illegal, and that a possible consequence of the stock
transfer--delisting from the New York Stock Exchange--would cause
irreparable injury to Norlin's shareholders. We hold that the district court's
findings were not erroneous, and therefore affirm. Before analyzing the legal
issues presented, we shall describe the events that gave rise to the present
dispute.
5

* Appellant Norlin Corporation ("Norlin") is a diversified company whose

principal lines of business are the manufacture of musical instruments and
financial printing. Norlin is incorporated in the Republic of Panama, but has no
significant operations in that country. The company's principal place of
business and executive offices are located in White Plains, New York, and its
shareholder and directors' meetings take place in New York as well.

Appellee Piezo Electric Products, Inc. ("Piezo") is primarily engaged in the

research, development, manufacture and sale of piezoelectric and thermistor
products. It is a Delaware corporation with its principal place of business in
Cambridge, Massachusetts. On the two trading days of January 6 and 12, 1984,
and in conjunction with the investment banking firm Rooney, Pace Inc., Piezo
purchased some 32% of Norlin's common stock in a number of separate
transactions. Fearful that a takeover attempt was imminent, Norlin filed suit on
January 13, alleging various violations of the federal securities laws. The
company sought to enjoin appellees from acquiring any additional Norlin stock,
to force divestiture of stock already purchased, and to bar voting of Norlin stock
owned by them. After hearing oral argument, Judge Edelstein denied Norlin's
motions for a temporary restraining order and expedited discovery, finding that
the company had not demonstrated irreparable harm stemming from the stock
purchases.

Having failed to secure protection in the courts, Norlin immediately took

defensive measures on its own. On January 20, 1984, the same day the judge
ruled on its motions, Norlin's board transferred 28,395 shares of common stock
to Andean Enterprises, Inc. ("Andean"), a wholly-owned subsidiary of Norlin
also incorporated in Panama. The transfer was purportedly made in
consideration for Andean's cancellation of a Norlin promissory note in the
amount of $965,454. Three days later, on January 23, Norlin announced it had

"retained the investment banking firm of Dillon, Read & Co., Inc. to explore
various opportunities which may be available to Norlin, including the merger or
sale of Norlin, the repurchase of shares of Norlin Common Stock or the sale or
issuance of shares or other securities of Norlin."
8

On January 25, Norlin's board approved two additional transfers of large blocks
of stock. The board conveyed 800,000 shares of authorized but unissued
preferred stock, which would vote on a share for share basis with Norlin
common, to Andean in exchange for a $20 million interest-bearing note. On the
same day, the board created the Norlin Industries, Inc. Employee Stock Option
Plan and Trust ("ESOP"), and appointed three Norlin board members as
trustees. The board immediately transferred 185,000 common shares to the
ESOP in consideration for a promissory note in the principal amount of
$6,824,945. In filings with the Securities and Exchange Commission, Norlin
acknowledged that it would be the beneficial owner of all of the transferred
shares. Moreover, it is undisputed that the board retained voting control of the
shares conveyed to Andean and to the ESOP. Together with shares already
under the board's control, the January 20 and 25 transactions resulted in the
Norlin directors controlling the votes of 49% of the corporation's outstanding
stock.

Also on January 25, Norlin's Chairman and Chief Executive Officer, Norton
Stevens, and President, Gilbert A. Simpkins, wrote to the company's
shareholders explaining these actions. Their letter mentioned the Piezo and
Rooney, Pace acquisitions, and asserted that "[t]he Board of Directors and
management are strongly opposed to the stated purposes of Rooney, Pace and
Piezo and are taking all steps deemed necessary or appropriate to protect
Norlin's shareholders and the value of their investment in the Company." The
letter offered no justification for the stock transfers to Andean and the ESOP
other than to ward off a prospective attempt to obtain control of Norlin.

10

Norlin's directors concede that prior to taking the steps described above, they
were warned by their financial advisers that absent shareholder approval, the
stock transactions violated the rules of the New York State Exchange
("NYSE") and might result in the delisting of Norlin common stock. On March
15, the NYSE did in fact suspend trading in Norlin common, and indicated its
intention to delist the stock. A release announcing the move explained:

11 Exchange said it deems [the stock issuances to Andean and to the ESOP] to
The
have resulted in a change in control of the company.
The Exchange said its policy requires that a company obtain shareholder approval in
12

such circumstances and it said its decision to delist the Norlin securities results from
the fact that Norlin didn't seek shareholder approval of the issuance.
13 addition Norlin is presently below the Big Board's continued listing criteria
In
relating to the number of publicly held shares--at least 600,000 shares--and the
number of holders of 100 shares or more--at least 1,200--the Exchange said.
14

On February 9, some time before the NYSE announcement was issued, Piezo
filed the counterclaim that is the basis of the instant action. Its complaint
alleged that the Norlin stock transfers violated Panama and New York law in
addition to several provisions of the federal securities laws. Piezo contended
that the transactions had no valid business purposes, and were intended solely
"to further entrench management by placing additional shares of voting stock at
management's disposal." To forestall delisting from the NYSE, as well as other
alleged harms to Piezo in its capacity as a Norlin shareholder, the
counterclaimant sought to have the issuance of shares to Andean and the ESOP
declared void, and to bar Norlin from voting those shares for any purpose.

15

Piezo subsequently moved for preliminary relief, and Judge Edelstein heard
argument on the motion. In a written order entered April 16, the judge granted
Piezo's application for a preliminary injunction. He stated that Panamanian law
barred Norlin from voting the shares transferred to its wholly-owned
subsidiary, and that the issuance of the ESOP shares was "clearly part of the
same management scheme to entrench itself in power...." His order also
concluded that Piezo had met its burden of demonstrating irreparable harm,
"because the delisting of the common stock together with the inability of
purchasers generally to acquire over-the-counter shares on margin seriously
limits the liquidity of such shares; and further, the delisting of securities
generally is a serious loss of prestige and has a chilling effect on prospective
buyers...." Based upon these determinations, the judge barred Norlin from
voting the contested shares pending further proceedings, and ordered Norlin to
take "all reasonable steps necessary and desirable" to prevent delisting from the
NYSE.

16

On appeal, Norlin takes issue with every one of Judge Edelstein's findings and
conclusions, arguing that its actions were well within the board's discretion
once it determined that Piezo's designs were not in the company's best interest.
Before we turn to the merits of Norlin's arguments, we must dispose of several
preliminary issues which provide the context for our discussion.

II

17

We begin by delineating the scope of our review. In this Circuit, a preliminary

injunction will not issue without a showing of irreparable harm. See Jackson
Dairy, Inc. v. H.P. Hood & Sons, Inc., 596 F.2d 70, 72 (2d Cir.1979). In
addition, the moving party must demonstrate either a likelihood of success on
the merits, or sufficiently serious questions going to the merits and a balance of
hardships tipping decidedly in favor of equitable relief. See Arthur Guinness &
Sons, PLC v. Sterling Publishing Co., Inc., 732 F.2d 1095, 1099 (2d Cir.1984).
The injunction granted by the district court was predicated upon the first of
these alternative grounds.

18

As a general rule, a preliminary injunction will be sustained on appeal absent

an abuse of discretion by the lower court. Jack Kahn Music Co., Inc. v. Baldwin
Piano & Organ Co., 604 F.2d 755, 758 (2d Cir.1979). The propriety of this
principle stems from our recognition that a trial court is in a better position to
assess the credibility of testimony and make factual findings than an appellate
court. The rule is, however, bounded by its own rationale. Where there has
been no evidentiary hearing, and the decision below is based entirely upon legal
arguments and papers submitted to the court, we may undertake our own
review of the pleadings, affidavits and depositions to ascertain the correctness
of the district judge's ruling. See Dopp v. Franklin National Bank, 461 F.2d
873, 879 (2d Cir.1972). In particular, when the granting of an injunction rests
upon an error of law, that in itself constitutes a ground for reversal. See Buffalo
Courier-Express, Inc., v. Buffalo Evening News, Inc., 601 F.2d 48, 59 (2d
Cir.1979).

19

Norlin initially raises a procedural barrier which, it contends, prevents Piezo

from asserting any claim for relief arising from the stock transfers. Norlin
argues that New York courts subscribe to the "internal affairs rule," under
which the law of the jurisdiction of incorporation governs internal corporate
matters, including the existence and extent of corporate fiduciary obligations.
Because Norlin is a Panamanian corporation, it contends, a New York court
under this doctrine would apply Panama law to determine whether Norlin's
shareholders have a cause of action against its directors for breach of their
fiduciary duty. According to the affidavits of Panamanian lawyers submitted on
Norlin's behalf, however, Panama law conditions the existence of a cause of
action by shareholders against directors upon the passage of a resolution
authorizing the lawsuit at a general meeting of shareholders. Neither party
suggests that such a resolution has been proposed or adopted. Hence, Norlin
asserts, Piezo has failed to state a claim for relief.

20

We need not discuss the fidelity of New York courts to the internal affairs rule

at this juncture, although we shall return to that issue infra. We find it

unnecessary to adopt the choice of law ruling Norlin urges, because the New
York legislature has expressly decided to apply certain provisions of the state's
business law to any corporation doing business in the state, regardless of its
domicile. Thus, under New York Business Corporation Law ("NYBCL") Sec.
1319,3 a foreign corporation operating within New York is subject, inter alia, to
the provisions of the state's own substantive law that control shareholder
actions to vindicate the rights of the corporation. NYBCL Sec. 626,4 made
applicable to foreign corporations by Sec. 1319, permits a shareholder to bring
an action to redress harm to the corporation, including injury wrought by the
directors themselves. See Barr v. Wackman, 36 N.Y.2d 371, 368 N.Y.S.2d 497,
329 N.E.2d 180 (1975).
21

Section 626(c) requires a prospective plaintiff-shareholder to make a demand

on the board to initiate action directly, before bringing suit on the corporation's
behalf. Piezo does not claim to have taken that step. It has long been
established, however, that such a demand may be excused if it would be an idle
gesture, as in a situation similar to that before us, where it would be directed to
the very persons against whom relief is sought. Continental Securities Co. v.
Belmont, 206 N.Y. 7, 99 N.E. 138 (1912). A demand would be particularly
futile when "[a]cting officially, the board, qua board, is claimed to have
participated or acquiesced in assertedly wrongful transactions," Barr v.
Wackman, supra, 36 N.Y.2d at 379, 368 N.Y.S.2d at 506, 329 N.E.2d at 187.
That is precisely the case here. Contrary to appellants' argument, therefore,
appellee could proceed under New York law and assert the claims at issue.
Accordingly, we turn to Piezo's likelihood of success on the merits of its
claims.

III
22

Piezo asserts, and the district court appropriately found, that the illegality of
voting the stock transferred to Andean and the ESOP had been demonstrated
with sufficient certainty to warrant injunctive relief. As we will explain, the
right of a wholly-owned subsidiary to vote shares of a parent company's stock
is controlled by statute. The propriety of an issuance of stock to an ESOP in the
context of a contest for corporate control has not been legislatively resolved,
and so must be assessed in relation to fiduciary principles governing the
conduct of officers and directors. Thus, we must analyze the two issues
separately.

A. Voting of Andean's shares.

23
24

Both New York and Panamanian law expressly prohibit a subsidiary that is

24

Both New York and Panamanian law expressly prohibit a subsidiary that is
controlled by its parent corporation from voting shares of the parent's stock.
NYBCL Sec. 612(b) provides:

25
Treasury
shares and shares held by another domestic or foreign corporation of any
type or kind, if a majority of the shares entitled to vote in the election of directors of
such other corporation is held by the corporation, shall not be shares entitled to vote
or to be counted in determining the total number of outstanding shares.
26

Article 35 of Panamanian Cabinet Decree 247 of July 16, 1970, part of the
corporation law of Panama, states the same rule in somewhat different terms:

27
Shares
of a corporation owned by [an]other corporation in which the former
corporation owns the majority of shares shall not be entitled to vote at Meetings of
Shareholders nor shall be deemed as issued and outstanding shares for purposes of
quorum.
28

Both statutes seek to safeguard minority shareholders from management

attempts at self-perpetuation. If cross-ownership and cross-voting of stock
between parents and subsidiaries were unregulated, officers and directors could
easily entrench themselves by exchanging a sufficient number of shares to
block any challenge to their autonomy. See Hornstein, Corporate Law and
Practice Sec. 311, at 410 (1959).

29

Norlin, however, contends that neither New York nor Panama law should be
applied to bar Andean from voting the Norlin shares it owns. New York, Norlin
argues, applies the internal affairs rule (discussed supra ) to issues of corporate
governance. Thus, a New York court would look to the law of Panama, as the
state of incorporation, to decide whether Andean can vote its shares. But under
Article 37 of the above-mentioned Panamanian Cabinet Decree, the prohibition
contained in Article 35 is applicable only "to corporations registered at the
National Securities Commission [of Panama] and to such corporations whose
shares are sold in the market, although such corporations do not offer their own
shares to the public." In other words, unless a corporation undertakes to list its
shares for sale in Panama, or its shares are in fact sold in that country, the
proscription contained in Article 35 does not govern.

30

The district judge appears to have accepted the argument that Panama law is
controlling. He found, based upon an affidavit offered by Piezo, that a purchase
of Norlin stock had been made through a branch office of Merrill, Lynch,
Pierce, Fenner & Smith located in Panama City. Thus, while Norlin shares
concededly are not registered at the Securities Commission, the judge

determined that they were "sold in the market," and so governed by Article 35.
On appeal, however, appellants have brought to our attention a recent opinion
by the General Attorney of Panama, dated May 2, 1984, which interprets the
requirement that shares be "sold in the market," the alternative predicate to the
application of Article 35. The opinion states that a company's shares are not
deemed to be "sold in the market" if it "sell[s] shares in a private manner to a
number of persons of no mre [sic] than 10 per year." Because Piezo has only
documented a single sale of Norlin stock, Norlin urges, Piezo has not
demonstrated that Panama law should govern the voting of shares owned by
Andean.
31

We accept the initial premise of Norlin's argument--that a federal court

adjudicating a state law claim must apply the choice of law principles of the
forum state. Klaxon Co. v. Stentor Electric Manufacturing Co., Inc., 313 U.S.
487, 496, 61 S.Ct. 1020, 1021, 85 L.Ed. 1477 (1941). We are not so certain,
however, that a New York court would apply the internal affairs rule and
decide this case by reference to Panama law. In Greenspun v. Lindley, 36
N.Y.2d 473, 369 N.Y.S.2d 123, 330 N.E.2d 79 (1975), the Court of Appeals
confronted the question whether New York or Massachusetts law should
govern a shareholder's derivative action brought in a New York court against
the trustees of a business trust organized under laws of Massachusetts. Although
holding that Massachusetts law controlled, the court rejected "any automatic
application of the so-called 'internal affairs' choice-of-law rule...." 36 N.Y.2d at
478, 369 N.Y.S.2d at 126, 330 N.E.2d at 81. In accepting the application of
Massachusetts law as expressly provided in the declaration of trust, the court
noted:

32
[T]his
record is barren of proof of a significant association or cluster of significant
contacts on the part of the investment trust with the State of New York to support a
finding of such "presence" of the investment trust in our State as would, irrespective
of other considerations, call for the application of New York law. There is no record
proof of where the business of the trust is transacted, where its principal office is
located or its records kept, where the trustees meet, what percentage of the
investment portfolio relates to real property situate in New York, what proportion of
the shareholders reside in New York State or of other facts on which a finding of
such "presence" in New York State might be predicated.
33

The court expressly left open the question of what law would be applied in a
case in which some or all of these factors dictated the application of New York
law. See, e.g., Skolnik v. Rose, 55 N.Y.2d 964, 449 N.Y.S.2d 182, 434 N.E.2d
251 (1982); Rottenberg v. Pfeiffer, 86 Misc.2d 556, 383 N.Y.S.2d 189
(Sup.Ct.1976), aff'd, 59 A.D.2d 756, 398 N.Y.S.2d 703 (1977); cf. Restatement

(Second) of Conflicts of Laws Sec. 309, comment c (law of state other than
state of incorporation may apply "where the corporation does all, or nearly all,
of its business and has most of its shareholders in this other state and has little
contact, apart from the fact of its incorporation, with the state of
incorporation").
34

Norlin's contacts with the State of New York are far from insubstantial. The
company's principal place of business is located within the state, and its board
of directors meets here. The resolution approving the contested stock issuances
were adopted in this state, and the company stock has been traded on the
NYSE. Whether these contacts are sufficient for a New York court to apply
New York law is, in our view, a question that does not lend itself to a simple
answer. We need not, however, grapple with it to resolve the present inquiry.
The principles compelling a forum state to apply foreign law come into play
only when a legitimate and substantial interest of another state would thereby
be served. See Intercontinental Planning, Ltd. v. Daystrom, Inc., 24 N.Y.2d
372, 385-86, 300 N.Y.S.2d 817, 828, 248 N.E.2d 576 (1969); Traynor, Is This
Conflict Really Necessary?, 37 Tex.L.Rev. 657, 667-70 (1959). Conversely,
when the interests of only one state are truly involved, the purported conflict is
purely illusory. Thus, there is no reason why the law of the forum state should
not control. See Krauss v. Manhattan Life Insurance Co., 643 F.2d 98, 100-101
(2d Cir.1981).

35

In this case, Panama apparently would refrain from applying its own law to the
transactions under scrutiny, because appellant does not meet the criteria of
Article 37, as interpreted by the General Attorney. In essence, Panama has
made a determination that its interest in Norlin's affairs is insufficient to
warrant the application of Panamanian law to this dispute. New York, as the
forum state, has a more than adequate number of contacts with Norlin to give it
a legitimate interest in regulating these corporate actions.

36

Moreover, it is of interest to note that the relevant rules of law in New York and
Panama are identical on this point: A wholly-owned subsidiary may not vote
shares of its parent's stock. In these circumstances, it would be an absurd result
indeed if neither jurisdiction could apply its law, and the public policy of both
should be frustrated. See Leflar, American Conflicts Law Sec. 93, at 188 (3d
ed. 1977). We therefore conclude that whatever choice of law principles would
be applied, Piezo has made an adequate showing on these facts that the voting
of Andean's shares would be unlawful.

B. Voting of shares held by the ESOP

37

We now turn to the district court's conclusion that appellee had demonstrated
probable illegality stemming from the voting of Norlin shares held by the
ESOP. This is a somewhat more difficult problem, for we have little statutory
authority to guide us in our quest. We must look instead to those fiduciary
principles of state common law which constrain the actions of corporate
officers and directors.5

38

A board member's obligation to a corporation and its shareholders has two

prongs, generally characterized as the duty of care and the duty of loyalty. The
duty of care refers to the responsibility of a corporate fiduciary to exercise, in
the performance of his tasks, the care that a reasonably prudent person in a
similar position would use under similar circumstances. See NYBCL Sec. 717.
In evaluating a manager's compliance with the duty of care, New York courts
adhere to the business judgment rule, which "bars judicial inquiry into actions
of corporate directors taken in good faith and in the exercise of honest judgment
in the lawful and legitimate furtherance of corporate purposes." Auerbach v.
Bennett, 47 N.Y.2d 619, 629, 419 N.Y.S.2d 920, 926, 393 N.E.2d 994 (1979).

39

The second restriction traditionally imposed, the duty of loyalty, derives from
the prohibition against self-dealing that inheres in the fiduciary relationship.
See Pepper v. Litton, 308 U.S. 295, 306-07, 60 S.Ct. 238, 245-46, 84 L.Ed. 281
(1939). Once a prima facie showing is made that directors have a self-interest in
a particular corporate transaction, the burden shifts to them to demonstrate that
the transaction is fair and serves the best interests of the corporation and its
shareholders. See NYBCL Sec. 713(a)(3); Schwartz v. Marien, 37 N.Y.2d 487,
493, 373 N.Y.S.2d 122, 127, 335 N.E.2d 334 (1975); Limmer v. Medallion
Group, Inc., 75 A.D.2d 299, 428 N.Y.S.2d 961, 963 (1980); see also Marsh,
Are Directors Trustees?, 22 Bus.Law. 35, 43-48 (1966).

40

In applying these principles in the context of battles for corporate control, we

begin with the business judgment rule, which affords directors wide latitude in
devising strategies to resist unfriendly advances. See, e.g., Treadway
Companies, Inc. v. Care Corp., 638 F.2d 357, 380-84 (2d Cir.1980); CrouseHinds Co. v. Internorth, Inc., 634 F.2d 690, 701-04 (2d Cir.1980). As Judge
Kearse made clear in those cases, however, the business judgment rule governs
only where the directors are not shown to have a self-interest in the transaction
at issue. Treadway, 638 F.2d at 382. Once self-dealing or bad faith is
demonstrated, the duty of loyalty supersedes the duty of care, and the burden
shifts to the directors to "prove that the transaction was fair and reasonable to
the corporation." Id.; Crouse-Hinds, 634 F.2d at 702; Panter v. Marshall Field
& Co., 646 F.2d 271, 301 (7th Cir.1981) (Cudahy, J., concurring and

dissenting), cert. denied, 454 U.S. 1092, 102 S.Ct. 658, 70 L.Ed.2d 631 (1981);
Johnson v. Trueblood, 629 F.2d 287, 300 (3d Cir.1980) (Rosenn, J., concurring
and dissenting), cert. denied, 450 U.S. 999, 101 S.Ct. 1704, 68 L.Ed.2d 200
(1981); see Klaus v. Hi-Shear Corp., 528 F.2d 225, 233-34 (9th Cir.1975);
Mobil Corp. v. Marathon Oil Co., [1981 Transfer Binder] Fed.Sec.L.Rep.
(CCH) p 98,375 (S.D.Ohio), rev'd on other grounds, 669 F.2d 366 (6th
Cir.1981); cf. Bennett v. Propp, 41 Del.Ch. 14, 187 A.2d 405, 409 (1962).
41

In this case, the evidence adduced was more than adequate to constitute a prima
facie showing of self-interest on the board's part. All of the stock transferred to
Andean and the ESOP was to be voted by the directors; indeed, members of the
board were appointed trustees of the ESOP.6 The precipitous timing of the
share issuances, and the fact that the ESOP was created the very same day that
stock was issued to it, give rise to a strong inference that the purpose of the
transaction was not to benefit the employees but rather to solidify management's
control of the company. This is buttressed by the fact that the board offered its
shareholders no rationale for the transfers other than its determination to
oppose, at all costs, the threat to the company that Piezo's acquisitions
ostensibly represented. Where, as here, directors amass voting control of close
to a majority of a corporation's shares in their own hands by complex,
convoluted and deliberate maneuvers, it strains credulity to suggest that the
retention of control over corporate affairs played no part in their plans.7

42

We reject the view, propounded by Norlin, that once it concludes that an actual
or anticipated takeover attempt is not in the best interests of the company, a
board of directors may take any action necessary to forestall acquisitive moves.
The business judgment rule does indeed require the board to analyze carefully
any perceived threat to the corporation, and to act appropriately when it decides
that the interests of the company and its shareholders might be jeopardized. As
we have explained, however, the duty of loyalty requires the board to
demonstrate that any actions it does take are fair and reasonable. We conclude
that Norlin has failed to make that showing.

43

ESOP's, like other employee benefit plans, may serve a number of legitimate
corporate purposes, and their creation is generally upheld in the courts when
they do so.8 Cf. Diamond v. Davis, 62 N.Y.S.2d 181 (Sup.Ct.1945). By
establishing an ESOP, corporate managers may seek to improve employee
morale and loyalty, see Herald Co. v. Seawell, 472 F.2d 1081, 1096 (10th
Cir.1972), to raise capital for the corporation, id. at 1095, or to supplement
employee compensation or retirement benefits, Weinberg v. Cameron, [197980 Transfer Binder] Fed.Sec.L.Rep. (CCH) p 97,377 (D.Hawaii 1980). When
an ESOP is set up in the context of a contest for control, however, it devolves

upon the board to show that the plan was in fact created to benefit the
employees, and not simply to further the aim of managerial entrenchment. In
applying that distinction, courts have looked to factors such as the timing of the
ESOP's establishment, the financial impact on the company, the identity of the
trustees, and the voting control of the ESOP shares. See Note, Employee Stock
Ownership Plans and Corporate Takeovers: Restraints on the Use of ESOPs by
Corporate Officers and Directors to Avert Hostile Takeovers, 10 Pepperdine
L.Rev. 731, 744 (1983).
44

In this case, an examination of each of these factors indicates that the ESOP
was created solely as a tool of management self-perpetuation.9 It was created a
mere five days after the district court refused to enjoin further stock purchases
by Piezo, and at a time when Norlin's officers were clearly casting about for
strategies to deter a challenge to their control.10 No real consideration was
received from the ESOP for the shares.11 The three trustees appointed to
oversee the ESOP were all members of Norlin's board, and voting control of all
of the ESOP shares was retained by the directors.12 We therefore conclude that
the record supports the finding that the transfer of stock to the ESOP was part
of a management entrenchment effort.

45

Norlin, however, urges that even if the creation of the ESOP was not fair and
reasonable in itself, it served other important corporate and shareholder
interests, and hence should not be deemed unlawful. First, Norlin argues that a
Piezo takeover would jeopardize a $25 million net operating loss carryforward
currently on the company's books. This concern appears somewhat
disingenuous in light of Norlin's own statement, in a letter to the NYSE, that "
[i]n Norlin's view, it is likely that Rooney Pace and Piezo, if they achieve
control, could have a public sale to safeguard the net operating loss carryforward." But even if Norlin's fears were legitimate, that would only help to
justify the board's determination that an anticipated takeover attempt should be
opposed as not in the corporation's best interest. It has no relevance to our
evaluation whether the actions taken by the board in response to that decision
were fair and reasonable. In a similar vein, the company contends that its
actions were an appropriate response to reports of Rooney Pace's "unsavory
reputation," and to the possibility that Norlin's financial printing business might
suffer if an investment house should acquire control. Again, this concern,
however real it may be, does not help to establish the independent legitimacy of
the actions taken by the board to counter a perceived threat.

46

Norlin's final justification, and one emphasized at oral argument, was that the
board needed to consolidate control to "buy" time to explore financial
alternatives to a Piezo takeover. The company asserts that the shareholders will

benefit if the directors are insulated from challenges to their control, for an
interim period of unspecified duration, so that all of Norlin's future operations
can be considered with professional guidance. This argument stands our prior
cases on their heads. It is true that in conformity with the duty of care, we have
required corporate managers to examine carefully the merits of a proposed
change in control. We have also urged consultation with investment specialists
in undertaking such analysis. See, e.g., Treadway, 638 F.2d at 384. The purpose
of this exercise, however, is to insure a reasoned examination of the situation
before action is taken, not afterwards. We have never given the slightest
indication that we would sanction a board decision to lock up voting power by
any means, for as long as the directors deem necessary, prior to making the
decisions that will determine a corporation's destiny. Were we to countenance
that, we would in effect be approving a wholesale wresting of corporate power
from the hands of the shareholders, to whom it is entrusted by statute, and into
the hands of the officers and directors.
47

We thus find that Piezo has succeeded in demonstrating the likelihood of

success on the merits, with regard to the share issuances to both Andean and the
ESOP.13 We move on to the other requirement for the issuance of a preliminary
injunction: a showing of irreparable harm.

IV
48

Judge Edelstein based his finding of irreparable harm upon the probability that
Norlin common stock would be delisted from the NYSE if shareholder
approval were not obtained for the stock transfers. In prior cases, we have
noted the importance of NYSE listing to a corporation and its shareholders.
Listing on the "Big Board" protects the liquidity of shares, and reassures
shareholders and potential purchasers that the extensive NYSE listing
requirements are being met. See Sonesta Int'l Hotels Corp. v. Wellington
Associates, 483 F.2d 247, 254 (2d Cir.1973). Moreover, as we noted in Van
Gemert v. Boeing Co., 520 F.2d 1373 (2d Cir.1975), cert. denied, 423 U.S. 947,
96 S.Ct. 364, 46 L.Ed.2d 282 (1975), the investing public places great stock in
these protections:

49[L]isting on the New York Stock Exchange carries with it implicit guarantees of
...
trustworthiness. The public generally understands that a company must meet certain
qualifications of financial stability, prestige, and fair disclosure, in order to be
accepted for that listing, which is in turn so helpful to the sale of the company's
securities. Similarly it is held out to the investing public that by dealing in securities
listed on the New York Stock Exchange the investor will be dealt with fairly and
pursuant to law.

50

Id. at 1381. Cf. United Funds, Inc. v. Carter Products, Inc., [1961-64 Transfer
Binder] Fed.Sec.L.Rep. (CCH) p 91,288 (Balt.Cir.Ct. May 16, 1963) (enjoining
stock issuance that would lead to loss of NYSE listing, which constituted
"valuable corporate asset").

51

Norlin makes two attacks on the district judge's finding of irreparable harm.
First, the company argues that its stock will suffer no loss of liquidity from
NYSE delisting, because the shares are and will continue to be traded on
NASDAQ, which Norlin asserts is a comparable market in all respects. At best,
this undercuts only one of the three reasons for maintaining NYSE listing. It
does not respond to the point that investors rely heavily upon the rules of the
NYSE to insure fair dealing in corporate matters. Indeed, the fact that Norlin
stock continues to be traded on NASDAQ even while it is suspended on the
NYSE suggests that this investor confidence may be well placed. In addition,
Norlin's assertion does not contradict Judge Edelstein's finding that "delisting of
securities generally is a serious loss of prestige and has a chilling effect on
prospective buyers...."

52

Moreover, Norlin's present cavalier attitude towards delisting 14 is belied by the

company's previous actions and statements. On February 22, 1984, Norlin's
corporate secretary sent an eighteen-page letter to a NYSE official, in an
attempt to persuade the Exchange to continue listing its common stock. In the
letter, the company suggested that dire consequences might flow from
delisting:

53 steps taken by the NYSE to delist the Common Stock at this time, while
Any
substantial legal issues remain unresolved, may be perceived (however incorrectly)
as a judgment on the appropriateness of Norlin's actions and, accordingly, may tilt
the balance against Norlin's position. The inadvertent result of initiating delisting
proceedings could be panic selling by Norlin shareholders, probably (directly or
indirectly) to Rooney Pace and Piezo, the least desired of all results, since at that
point there would be no remaining opportunity to maximize the value of the
remaining shareholders' investment in Norlin.
54

In addition, the deposition testimony of Norlin's own investment banker,

Robert Pilkington, undermines the company's assertions of market
interchangeability. Pilkington testified that in his discussions with Norlin's
board regarding possible actions, he indicated that "the New York Stock
Exchange was the premier stock exchange in the United States and many
companies regarded it as an advantage to be listed on the New York Stock
Exchange." Pilkington listed several advantages to NYSE listing, including the
"feeling that you have a better market", the "advantage from the reputation

standpoint", and the fact that the NYSE has "the advantages of the specialist
system." And Pilkington conceded that delisting was "something you would not
try and obtain", but that on the contrary, "You would try and maintain your
New York Stock Exchange listing."
55

As a second argument, Norlin contends that an injunction should not have

issued because that action will not prevent delisting. In addition to the stock
issuances without shareholder approval, the company is out of compliance with
two other NYSE listing criteria, relating to the number of publicly held shares
and the number of holders of "round lots" of 100 shares or more. The district
judge was well aware of this when he issued the injunction, and properly noted
that "[t]his court may give relief only for violations that are appropriately
before it." In any event, there is no merit to Norlin's argument. The NYSE
release announcing its decision to suspend trading in Norlin stock could not
have been more explicit in stating that "the decision to delist the Norlin
securities results from the fact that Norlin didn't seek shareholder approval of
the issuance."

56

Under NYSE rules, moreover, failure to comply with listing criteria does not
automatically result in delisting. Section 801.00 of the NYSE Listed Company
Manual provides that "when a company falls below any criterion, the Exchange
will review the appropriateness of continued listing. The Exchange may give
consideration to any definitive action that a company would propose to take
that would bring it in line with original listing standards." Thus, to the extent
that non-compliance with the criteria might ultimately lead the NYSE to delist
Norlin stock, the remedy lies within Norlin's, not Piezo's, control. Accordingly,
we find no error in the district court's determination of irreparable harm.

V
57

In analyzing the issues presented to us, we have been mindful of the

preliminary stage at which this litigation stands. Developments in corporate
control contests often proceed swiftly, and timing may have a crucial impact on
the outcome. A more complete record will also be required to reach a final
adjudication of the merits of Norlin's and Piezo's competing claims. We would
therefore urge the district judge to proceed expeditiously to a trial on the
important issues raised by the parties.

58

This case well illustrates the increasing complexity and bitterness of the tactics
employed by contestants vying for corporate dominion. As here, each new
offensive may be met with a counter-offensive intended, in turn, to weaken the
aggressor. When these maneuvers fail, the courts themselves are too often

drawn into the fray.

59

Although we are cognizant that takeover fights, potentially involving billions of

dollars, profoundly affect our society and economy, it is not for us to make the
policy choices that will determine whether this style of corporate warfare will
escalate or diminish. Our holding here is not intended to reflect a more general
view of the contests being played out on this and other corporate battlefields.
We do, however, believe that a preliminary injunction was warranted in this
case. Whatever denouement may flow from the events that have transpired, the
rules of fairness we have outlined must govern the actions taken by both sides.
Because Piezo has succeeded in demonstrating probable illegality in the
issuance of shares to Andean and the ESOP, as well as irreparable harm
therefrom, we agree that the voting of those shares should, pending further
proceedings, be enjoined. Accordingly, the order of the district court is
affirmed.

See, e.g., Easterbrook and Fischel, "The Proper Role of a Target's Management
in Responding to a Tender Offer," 94 Harv.L.Rev. 1161 (1981); Gelfond and
Sebastian, "Reevaluating the Duties of Target Management in a Hostile Tender
Offer," 60 B.U.L.Rev. 403 (1980)

See, e.g., Lipton, "Takeover Bids in the Target's Boardroom," 35 Bus.Law. 101
(1979); Steinbrink, "Management's Response to the Takeover Attempt," 28
Case W.L.Rev. 882 (1978)

NYBCL Sec. 1319 provides in pertinent part:

(a) ... the following provisions, to the extent provided therein, shall apply to a
foreign corporation doing business in this state, its directors, officers and
shareholders:
....
(2) Section 626 (Shareholders' derivative action brought in the right of the
corporation to procure a judgment in its favor).
....

NYBCL Sec. 626 provides in part:

(a) An action may be brought in the right of a domestic or foreign corporation
to procure a judgment in its favor, by a holder of shares or of voting trust

certificates of the corporation or of a beneficial interest in such shares or

certificates.
(b) In any such action, it shall be made to appear that the plaintiff is such a
holder at the time of bringing the action and that he was such a holder at the
time of the transaction of which he complains, or that his interest therein
devolved upon him by operation of law.
(c) In any such action, the complaint shall set forth with particularity the efforts
of the plaintiff to secure the initiation of such action by the board or the reasons
for not making such effort.
5

In issues involving the fiduciary duty of a corporate board of directors, a federal

court must look to state rather than federal common law. See Burks v. Lasker,
441 U.S. 471, 478, 99 S.Ct. 1831, 1837, 60 L.Ed.2d 404 (1979)

While a conflict of interest does not necessarily arise when directors serve
simultaneously as trustees of an ESOP established by their corporation, the
possibilities for such conflicts are rampant. See, e.g., Donovan v. Bierwirth,
680 F.2d 263 (2d Cir.1982)

We do not think our conclusion on this point is inconsistent with the findings in
Treadway and Crouse-Hinds that no prima facie showing of conflict of interest
had been made. The facts in this case differ in significant respects. Treadway
involved the sale of 230,000 shares of Treadway Companies, Inc. stock to Fair
Lanes, Inc., preparatory to a merger between the two companies. The
agreement to sell the shares was reached sometime after a third party, Care
Corporation, had acquired a large block of Treadway stock. Care claimed that
Treadway's board had approved the sale to Fair Lanes for the improper purpose
of perpetuating its control over the corporation. Judge Kearse, writing for this
court, found that Care had failed to establish a conflict of interest on the part of
Treadway's board. Her opinion specifically noted evidence that Fair Lanes had
been interested in merging with Treadway for a number of years, that all of
Treadway's directors but one anticipated losing their positions if the merger
with Fair Lanes were consummated, and that the merger was not merely a
"sham or a pretext," but rather a viable business proposition. Treadway, 638
F.2d at 383. No analogous facts are present here
Crouse-Hinds also involved a three-way competition for corporate control. In
that case, Crouse-Hinds Co. and Belden Corporation entered into an agreement
whereby Belden would be merged into a Crouse-Hinds subsidiary. Four days
after the agreement was reached, Internorth, Inc. made a tender offer for
Crouse-Hinds' shares, intending to follow that action with a merger of the two
companies. Subsequent to the tender offer, Crouse-Hinds and Belden

announced an Exchange Agreement permitting Belden shareholders to tender

their shares in exchange for Crouse-Hinds stock, at the same ratio of 1.24
Crouse-Hinds shares to 1 Belden share which was contemplated in the original
merger agreement. Internorth challenged the Exchange Agreement as a device
by the Crouse-Hinds board to retain control. In holding that board self-interest
had not been demonstrated, Judge Kearse noted that the Crouse-Hinds board
had no indication that Internorth would make a tender offer at the time the
merger agreement was entered into. Because the Exchange Agreement was a
reasonable means of facilitating a merger which was itself legitimate, no
showing of bad faith had been made. Crouse-Hinds, 634 F.2d at 703-04. Again,
these facts are at considerable variance with those in the instant case.
8

Employee stock ownership plans meeting designated requirements are

authorized under federal law. See 29 U.S.C. Sec. 1107(d)(6); 26 U.S.C. Sec.
401(a)

The New York Court of Appeals has long held that directors may not issue
stock for the "primary purpose" of consolidating corporate control. See Dunlay
v. Avenue M. Garage & Repair Co., 253 N.Y. 274, 279-80, 170 N.E. 917
(1930)

10

Other courts have noted that the issuance of shares to an ESOP shortly after a
challenge to corporate control gives rise to an inference of improper motive.
See, e.g., Klaus v. Hi-Shear Corp., supra, 528 F.2d at 231-33; Podesta v.
Calumet Industries, Inc., [1978 Transfer Binder] Fed.Sec.L.Rep. (CCH) p
96,433 (N.D.Ill.1978). Norlin also argues that the ESOP had been under
consideration for some time, even though it was not created until a threat to the
company emerged. No more support for that assertion exists here than in HiShear Corp., 528 F.2d at 233, or Calumet Industries, p 96,433 at 93,556

11

Although a finding that the corporation received a fair price for shares
transferred is not essential to establishing that a transaction is in the company's
best interest, it is certainly relevant to the inquiry. See, e.g., Buffalo Forge Co.
v. Ogden Corp., 717 F.2d 757 (2d Cir.1983). In this case, Norlin received no
cash consideration for any of the shares issued to Andean or to the ESOP

12

Norlin argues that "Piezo's burden under the business judgment rule is all the
heavier because the Norlin board that approved [the stock issuances] was
overwhelmingly composed of independent 'outside' directors." We are not
persuaded that a different test applies to "independent" as opposed to "inside"
directors under the business judgment rule. See, e.g., Zapata Corp. v.
Maldonado, 430 A.2d 779 (Del.1981); Note, "The Misapplication of the
Business Judgment Rule in Contests for Corporate Control," 76 Nw.U.L.Rev.

980, 1001-03 (1982) and authorities cited therein. In any event, once a
collective conflict of interest underlying the board's action is shown, any such
distinction has no bearing on the fairness and reasonableness of the action
taken
13

Norlin cites the case of Southeastern Public Service Co. v. Graniteville Co.,
C.A. No. 83-1028-8 (D.S.C. May 19, 1983), as holding that the creation of an
ESOP is an appropriate step to thwart an attempt to acquire control of a
corporation. The court there stated: "... as I understand the law, there is no
breach of fiduciary duty if you oppose a tender offer, which in the best
judgment of management, is detrimental to the corporation or its shareholders,
and management may take steps they deem appropriate, including issuing stock
which does dilute the interest of tender offers [sic] in making self-tender
offers." This is, as we have explained, a correct statement of law absent a
showing of board self-interest. In this case such a showing has been made, so
the Graniteville holding is inapposite

N14 It is illuminating to compare Norlin's attitude with that of the board in the
Treadway case. Under the original agreement governing the sale of Treadway
shares to Fair Lanes, see supra note 5, Fair Lanes was to have had the right to
"put" or resell its shares to Treadway. When the American Stock Exchange
(AMEX) indicated that it would likely not list the shares in light of the "put"
feature, the agreement was "promptly abandoned." 638 F.2d at 366-67